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Is Manhattan Associates a Risky Stock?

By Brian Feroldi – Nov 10, 2019 at 7:10PM

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The supply chain software provider has grown like a weed over the past decade, but is this company built to last?

Manhattan Associates (MANH 0.36%), a leading provider of supply chain software and consulting services, has grown rapidly this year and delivered fantastic returns for investors. Can the company keep it up? Or is this stock too risky to touch?

In this episode of Industry Focus: Tech, host Dylan Lewis and contributor Brian Feroldi talk about the company's relationship with its customers, its corporate culture and management team, and any red flags investors need to be aware of.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Oct. 18, 2019.

Dylan Lewis: All right, Brian, we can't talk SaaS without talking customers. You're big on customer concentration and making sure that that's not the case for anything that you're buying. What's the picture with Manhattan Associates?

Brian Feroldi: Yeah, concentration is definitely not an issue here. They have hundreds of individual customers, and their largest customers do not make up an outsized portion of revenue, so we can check that box. When you think about what it takes to bring a customer into their business, that is a very expensive, very long process. They call out nine-plus-month sales cycle just to get a yes. And then, once they are chosen and implemented, that is a multi-month, if not multiyear process. So, acquiring customers is very expensive for this business. 

On the flip side, once a customer is in their ecosystem, they are very dependable sources of revenue, and going to become even more so as the company converts to the SaaS model. That's a major reason why we love when businesses go from licensing to SaaS. I think that there's reasons to believe that Manhattan Associates does have good relations with its customers, and it could even in time boast pricing power, because once they get in, it's so hard to switch over. That is something that I like to see as an investor.

Lewis: Something else I like to see is, management's been with the company for quite some time. You look at the people calling the shots. CEO Eddie Capel has been with the business for a good amount of time, and seems to be pretty well liked there, too.

Feroldi: He started at this company in 2000 in the management team. Worked his way up to take over the role as CEO in 2013. He has been at this company for a long time. If you check out his Glassdoor ratings, they're pretty good. 88% of employees approve of him as CEO. The business itself gets about 3.7 stars out of five. Those are good -- not stellar, but pretty good -- numbers. 

One knock I do have against this management team is that inside ownership is pretty low. CEO Capel owns about $10 million worth of stock, which is peanuts compared to the grand scheme of things. But that is enough of an incentive for him to continue to see the share price move higher. 

So, I would say, pretty good management in culture. Not the best we've seen, but by far not the worst.

Lewis: Yeah. To put that $10 million in context, I think they're currently trading at like $5.5 billion. That's roughly their valuation. This is definitely one of those companies that's in that mid-cap sweet spot when it comes to SaaS. They are big enough to have a sizable business, not so big that it becomes really interesting for one of the tech giants to hop in there and say, "You know what? I think we're going to get a piece of this, too."

Feroldi: Yeah, totally.

Lewis: All right, we're going to run through the red flags quickly. I know listeners like your checklist, Brian. I want to make sure that we don't miss anything over there on the risks side as well.

Feroldi: Sure. There are, of course, numerous risks for investors to keep in mind. But this isn't a penny stock of any kind. As we touched upon before, there's no customer concentration to worry about. One of the things I like to ask is, does this industry face long-term headwinds or tailwinds? I believe the answer is tailwinds, because retailers have huge pressure on them to invest in their omnichannel experience. 

One thing I will note is, one question I like to ask is, does this business rely on any outside force for success? And I think the answer there is sort of. They do sell a lot to retailers. That is their No. 1 customer segment. So, a healthy retail environment is important. If the retail sector in general took a big decline because a recession, you could see the case for retailers to make less investments into their business. That is something for investors to keep an eye on here. 

And then finally, I like to look at stock-based compensation. Stock-based compensation is actually very low for this company, about $19 million all of last year -- again, compared to a $5.5 billion market cap. So very, very small in the grand scheme of things. This company actually produces so much free cash flow and so much net income that they've actually been a net buyer of their stock over the last couple of years. The share count has actually declined by 13% in the last five years. That's something that investors should applaud.

Lewis: Yeah, if you look at the share price appreciation, too, it looks like a lot of those buybacks have been coming at pretty good valuations because the stock has just generally been up and to the right, particularly over the last year, but definitely over the last couple of years as well. 

I think, to mitigate one of those risks, talking about the dependency on retail, I do see that as a possibility. If you're running into several retail customers that are facing cash crunches, they may decide to lower their investment in the space. But, it's one of those things where, long-term, if retail wants to thrive, they need to be making these investments. I think that's where the industry is going, and they're in a good spot to take advantage of that.

Feroldi: Yeah, I totally agree. Even some struggling retailers that we've seen, sometimes they do have pressure on them from investors to return to growth. One way that they can do that is by really investing in their e-commerce capabilities and building out their omnichannel experience. That, again, pushes them into Manhattan Associates' hands. So there is a counter-argument to be made that weakness in the retail environment would increase the pressure on them to make investments in themselves. That could be a counter-balancing factor. 

As for the stock itself, you mentioned that the share price has been fabulous performing this year. It's about doubled since the start of the year. I think this is a very good, very dependable business that should just steadily crank out double-digit growth for the foreseeable future. But it is quite expensive right now. 55X forward earnings, and almost 10X sales. I wouldn't be in a rush to buy the stock today. But I do think it is a stock that tech investors should put on their radar.

Lewis: Yeah, I am definitely a fan of having a little post-it note with a couple of stocks that I'm interested in, particularly if we see a bad day in the market and I can start out a position, a small one, at a price that I really like. Having that watch list is huge. I think this is a company that absolutely deserves to be on people's watch lists.

Feroldi: Yeah, I totally agree with you. We've seen a lot of our favorite high-flying tech stocks really get crushed over the last six weeks. This stock has actually held up very well, which I think is because the company is already profitable and trades at a moderate valuation in comparison. If you want to get in on the SaaS conversion space, but you don't want to take on a huge amount of risk, this could be one to check out. 

Lewis: Thanks for putting another great stock on our radar and joining us today, Brian!

Feroldi: Anytime, Dylan!

Brian Feroldi owns shares of Manhattan Associates. Dylan Lewis has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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